Lululemon Challenged by Lawsuits

Sometimes, you get in one of those ruts where even the little things don't seem to go quite right. You get a flat tire, the store is out of marmalade, and you trip going up the escalator. It wouldn't be so bad if a few things were going right, but they just aren't. lululemon athletica (NASDAQ: LULU) feels your pain. The company just keeps finding itself on the receiving end of mediocre news.

First the company lost out on sales when it was forced to recall its overly sheer pants, then it lost its chief product officer, and then its CEO announced her departure. Now, Lululemon is under fire from investors, who have filed several class action lawsuits against the yoga retailer regarding its product issues. Will it ever fully recover?

The problem with pantsThe first lawsuit alleges that Lululemon misled investors about the real cost associated with the company's earlier sheer pants issue. It claims that during the time between the announcement of the issue and the newest earnings release, management talked up the speed and efficiency of its problem-solving, while secretly planning to remove CEO Christine Day from office.

Depending on your point of view, Day's departure is either an unrelated event or the second casualty in the sheer-pants scandal. Product Officer Sheree Waterson left in April, in a not-so-subtly timed announcement that coincided with Lululemon's "how we're going to fix this" press release.

The shortage of fabric for the pants caused a meaningful dent in Lululemon's sales last quarter. The company admitted to having to write off $17.5 million of unusable Luon -- the fabric used in the pants -- due to the quality issue. The shortage also contributed to a 90-basis-point product margin decline.

That opened the door for competition, which resulted in a hit to Lululemon's same-store sales growth. In its most recent earnings call, Under Armour called out the strong performance in its studio line in the first quarter. That line competes with Lululemon's yogawear, and likely saw an uptick due to the market leader's product issues.

Who knew whatThe issue isn't how bad the situation is, though -- it's what Lululemon said about the situation. The more detailed lawsuit has three claims against the company. First, that it purposefully cut down on Luon quality to boost its margins. Second, that the company then went on to discount its clothing in order to keep market share. Finally, that Day's removal had been in the works for some time. All of these things were going on, the suit claims, while the company put on a shining, "everything is fine" face for investors.

The press releases from the time in question certainly seem to put a good face on things. The announcement about the issue came on March 18, and then by April 3, the whole thing was sorted out.

On its fourth-quarter conference call and in its earnings release on March 21, the company updated its guidance for the quarter and year, based on a fall in comparable sales. It then met those expectations in the first quarter, for which results were announced last month. On the call, it said that the annual earnings-per-share impact would be around $0.21.

In the end, it seems hard to say that Lululemon was anything less than clear about the impact of the Luon shortage. While further investigation may show that the lawsuits are well-founded, the public face of the company seems fine to me. I understand investors' frustration, though. The stock is down 17% year to date, but there should be at least a little bounce once a new CEO is found. The company still seems fundamentally strong, although it needs to figure out its competitive position. For now, I'm still tentatively bullish on Lululemon.

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